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Preparing for a layoff

Dear Money Matters,
I work in the telecommunications industry, and my company is having layoffs almost monthly. I haven't been affected yet, but I want to be prepared for anything. The severance package would pay me through November, but I've also been saving in case of an emergency. I've placed the funds in a money market account and have $3,000 saved up. I'm also contributing $250 a month to it. Should I withdraw a portion of the funds to help pay off a credit card? The card is the only debt that I have besides my car. I really would like to get rid of this debt, but I don't know if I should use my savings to do it.
LT

Dear LT,
First, I hope everything works out in the best possible fashion for you. You're not alone in this sputtering economy. Countless employees who thought their jobs were secure are now finding out otherwise.

With that in mind, you're exceedingly prudent to be hunkering down and expecting the worst. I would urge you to continue feeding your emergency fund as much as possible. You'll be happy you didn't shortchange yourself, should you have to rely on it for living expenses.

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However, whether you should earmark a portion of your savings to help pay off a credit card depends on a variety of factors. Under normal circumstances, it usually makes mathematical sense to pay off the card. The reason is that you're likely paying more in interest on the card than you're earning with a money market fund. In fact, the disparity may be quite substantial. According to recent averages, a standard credit card's interest rate was a bit higher than 13.5 percent. By contrast, even a so-called "high yield" money market savings account was only earning 2.53 percent. Additionally, when investments in general are suffering due to poor economic conditions, it's always a sensible play to begin paying down all sorts of debt, including credit cards.

One element to your decision is the size of your credit card balance. If it's only a matter of a few hundred dollars, I don't think you'll suffer irreparable harm by pulling some funds from your money market to kill that debt. However, if you're looking at something approaching $1,000 or more, I would be a good deal more gun-shy. However wise it is to pay off a high interest card, you don't want to deplete your savings to a dangerously low level, particularly with uncertain economic times on the horizon. Of course, some would argue that a credit card paid down to zero could always be used in a pinch down the line, but I've never felt using a credit card for everyday living expenses was an appropriate choice.

There are, however, a few other alternatives:

  • Pay down a portion of the balance: You don't necessarily have to approach this with an all-or-nothing-at-all attitude. If the balance is more than you feel comfortable taking out in one shot, consider paring down your balance bit by bit, adding more to your pay down as funds permit. That way, you're at least shrinking your debt.

  • Transfer the balance to a lower-rate card: If you card is in the teens or higher in interest rate, look into a card with lower charges. Bankrate's credit card search engine can help you find a card that may be a good deal less expensive in interest charges. But pay attention to any annual fee that may be attached to a card; while the interest rate may be low, you can lose a fair portion of your savings to the yearly fee a company levies. Use Bankrate's credit card calculators to figure your interest rate savings and how much, if at all, you may lose to annual fees.

  • Get a home equity loan or line of credit: If you own your own home (I know you say your debt is limited, but many folks don't refer to a mortgage in the same manner), give some thought to transferring your credit card balance to a home equity loan or line of credit. For one thing, they're relatively inexpensive -- the going rate for home equity lines of credit is less than 5 percent, with certain loans going for less than 7 percent. Click here to search for current home equity rates. In the case of the line of credit, they can also offer a degree of payback flexibility; while the loan incurs a fixed monthly amount, a line of credit functions in a fashion similar to a credit card, fixing monthly payments based on your outstanding balance. And, finally, interest on both products, unlike credit card debt, is tax deductible, which further limits your eventual out-of-pocket costs.

-- Posted: July 16, 2002

More Money Matters columns
See Also
Insurance pays the mortgage after a layoff
What to do once you've been handed a pink slip
Financial advice glossary
More Money Matters stories

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